The ABCs of pension reform in Canada: Needs to be some 'intelligent' debate on plan changes

Inadequate retirement income is the focus of an upcoming December meeting of federal and provincial finance ministers. It comes on the heels of recommended overhauls of the pension system in Ontario, Nova Scotia, Alberta and British Columbia.

All proposals identified the need to provide Canadians broader access to large well-managed pension funds, especially for those without workplace-sponsored pensions. Between three and five million Canadians are not in employer pensions --or not saving enough.

The private sector is increasingly reluctant to give workers the gold-plated defined-benefit (DB) pension plans that are common in the public sector. But the 2008 crash highlighted the stock market risk defined-contribution (DC) plans place on the shoulders of employees.

The same applies to self-managed RRSPs for those with no pensions.Robert Brown, actuarial science professor at the University of Waterloo, says employers are increasingly reluctant to give workers the guaranteed payouts of traditional DB plans. But he says workers need more than just the hoped for payouts they are getting from DC plans and RRSPs.

The future may be a middle ground: A hybrid DB-DC plan that gives workers an expectation, but not a promise, of future investment returns. One prototype may be the "ABC" plan, a DC target-benefit plan proposed jointly by Alberta and British Columbia.

With the target plan, contributions paid by the employer are based on projected, or targeted, retirement benefits. But the benefits provided to participants at retirement are based on the performance of the investments, so are not guaranteed. In a bad market, the pension that workers have already earned may go down or it may rebound after a good market.

Dean Connor, president of Sun Life Financial Canada, says smaller companies and the self-employed should band together to create a "commingled" pension plan that lowers costs through economies of scale.

However, the ABC proposal is getting flak from union members who prefer the guarantees of traditional DB plans.

The Alberta Federation of Labour commissioned a study by PBI Actuarial Consultants Ltd. of Vancouver, to review the ABC plan. PBI president Tony Williams says DB plans actually offer more efficient models than DC plans and better risk-sharing between employers and employees.PBI disagrees with the concept of a DC platform that shifts all investment risk to employees. It's not realistic to believe employees who don't currently have pension plans would contribute 6% or 9% of pay to a plan like ABC's.

PBI produced various scenarios for so-called replacement ratios -- the ratio of income in retirement to employment income enjoyed just prior to retirement.

Financial planners suggest a 70% replacement ratio is a good rule of thumb, although actuary Malcolm Hamilton at Mercer has argued as little as 50% may be adequate. At the other extreme, Fidelity Investments Canada found 80% or more might be needed for the affluent.

PBI gave the Alberta Federation of Labour 30 scenarios, including, at the extreme end, a low-end replacement ratio of 14%. Public-sector unions in Alberta leapt at the opportunity and trumpeted the low 14% ratio.

It's a tactic that infuriates Robert Brown. He understands the union's reluctance to embrace ABC: they have "nice public-sector DB plans and don't want to lose them," he says.

The 14% is an "outlier" number using the example of a worker aged 35, earning $100,000 and making the absolute minimum contribution to the ABC plan.

"It upsets me that policy would be driven by one number: 14%, for a person making stupid decisions along the way, making no other contributions to retirement. The story doesn't hold water. The union wants to talk the public into believing this is a lousy plan," says Brown.The ABC plan offers some solid solutions, Brown says, and is "worthy of intelligent debate."